Every college and university has an outside scholarship
policy that specifies
what happens to your need-based financial aid package when you win a
merit scholarship. An outside scholarship is any scholarship
not awarded by the government or the school, such as a scholarship
provided by a private sector company, philanthropist or foundation.

Outside scholarships are considered resources, meaning that they
reduce your financial aid package dollar for dollar. The schools often
do not have a choice in the matter. Federal rules concerning
"overaward situations" require the school to reduce the financial aid
package when the sum of financial aid from all sources exceeds the
school's cost of education by more than $300. (Certain types of
grants, such as the Pell Grant, do not get reduced. An outside
scholarship is most likely to affect campus-based aid, such as the
FSEOG grant, Perkins loan and Federal Work-Study, and the Federal
Stafford loan and the college's own student aid funds.)

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You are required to report any outside scholarships to the school's
financial aid office. If you fail to report an outside scholarship,
you may be required to repay the school or the government all or part
of your need-based financial aid package.

The school's outside scholarship policy dictates how the outside scholarship is used to reduce the financial aid package. Most schools have favorable policies that first apply the outside scholarship to unmet need, and then reduce self-help (loans and work-study) before touching institutional grants. This lets you replace your loans, which must be repaid, with the outside scholarship. After all, it is in the school's best interest to encourage you to win outside scholarships.

In fact, some schools have outside scholarships that are designed to provide students with an incentive to win outside scholarships (e.g., increase the student stipend by 10% of the outside fellowship amount for graduate students who win prestigious fellowships).

Even if the school reduces grants before loans, you can still benefit from winning an outside scholarship. If you win more scholarships than you have need-based grants, the school will be forced to reduce your loans. Moreover, most schools will use the outside scholarship to reduce your loans before allowing it to affect federal and state grants

Many schools will work with the family to reduce the impact of the outside scholarship policy if the family is up front about reporting any outside scholarships. Besides applying the outside scholarships to self-help and gapping first, they may adjust cost-of-attendance to shelter some of the scholarship. For example, although many schools will not normally adjust cost of attendance to include the cost of a computer, art supplies, or cold weather gear, they might factor in these costs when needed to allow you to keep your outside scholarship.

Some schools will provide other benefits to scholarship winners, such as giving you priority in selecting a dorm room or working as a research assistant to coveted faculty. If your outside scholarships will result in an overaward situation, consider asking the sponsor to defer all or part of the award to a future year to allow it to offset a future year's loans.

For more information on overaward situations and regulations, visit ifap.ed.gov.